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August 27, 2012

Advisors’ Mistakes on Social Security Advice Hurt Widows

Preponderance of early claims results in significantly lower survivor benefits for widows

Advisors appear to lack sophistication in advising clients about taking Social Security benefits, leading to mistakes that fall hardest on aging widows. That is the conclusion of a new study just published as a working paper of the Pension Research Council, a retirement research center affiliated with the University of Pennsylvania’s Wharton School.

The paper’s authors, Mathew Greenwald, Andrew Biggs and Lisa Schneider, based their findings on a survey of 400 financial advisors, drawn from a variety of different backgrounds including wirehouse and independent advisors, among others.

Yet advisors do not present a barrier to the prevalent tendency of Americans to claim benefits before reaching the full retirement age of 66, thereby ensuring a smaller lifetime benefit into advanced years when many Americans no longer have the option of continued work. Age 62, the first year Americans may elect benefits, is also the most common age chosen to do so.

To cite just one scenario discussed in the study, for a “man in average health earning more than his wife and intending to retire at age 62 with assets of at $800,000, it would clearly be advantageous to the wife if the husband delayed claiming; nevertheless, only 32% [of advisors] suggested the husband should claim at age 62 and only 20% suggested that the man delay as long as possible. Claiming at 62 would result in a significantly lower survivor benefit for the widow later in life.”

In a phone interview with AdvisorOne, Biggs (left), an American Enterprise Institute scholar, attributed advisor errors to an overreliance on what is known as “break-even analysis,” which asks how long it would take for the higher payments of a delayed claim to compensate for the benefits an earlier claim would have ensured.

“Most economists think that’s kind of a simpleminded way of looking at it,” Biggs says, since it overlooks the fact that delayed benefits provide higher income when people typically have the fewest options and also neglects to factor in the higher spousal and survivor benefits a later claim can generate.

Biggs says the persistence of break-even analysis is understandable. “For decades, that’s how the Social Security Administration used to portray it to people,” he said.

It also doesn’t help, Biggs adds, that the typical American is disposed to early benefit claims. Europeans, he says, take longer vacations, whereas Americans take longer retirements.

“A lot of people don’t think about the retirement decision very much. ‘The benefits are available at 62; I’m going to take it.’”

To increase advisor effectiveness, Biggs calls for “greater outreach from the Social Security Administration to the financial advisor community in the sense that Social Security has been a source of information for them.”

And that’s starting to happen, he adds. “Social Security has policy experts, economists, actuaries [who can help]. Financial advisors do think about Social Security, but they have a lot of [other] things to work on.”

Biggs also highly recommends that advisors avail themselves of new types of software that take into account the complex interaction of retirement, spousal and survivor benefits based on ages, incomes and longevity expectations.

“Financial advisors probably can’t do these calculations themselves,” he says.

Another key issue the paper addresses is how advisors frame claiming decisions. Seen as a gamble or as a (break-even analysis) money-saving approach, people tend to claim early.

But these approaches ignore Social Security’s value as an annuity that protects people from running out of money in old age. Framed that way, as a form of insurance, people are more likely to delay claims for a higher guaranteed lifetime income.

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